U.S. Market Setting Up for a 2nd Half Rally

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 |  Includes: IVV, SPY, USO, UUP, XLF
by: Jason Schwarz

The turmoil caused by the credit crisis of Q1 caused many investors to leave the game and sit on the sidelines. The volatility was too much to handle. The question now is, when to re-enter the market? The S&P 500 is down 5% for the year but recent statements by influential market players suggest that now is the time to load up for a 2nd half rally. Three of the major areas of concern, financials (NYSEARCA:XLF), oil (NYSEARCA:USO), and the US dollar (NYSEARCA:UUP) appear to be setting us up for a run:

Financials

The CEO of Morgan Stanley (NYSE:MS), John Mack, said that the global credit crisis might be "in the final innings." Treasury Secretary Henry Paulson said U.S. financial markets are emerging from the credit crunch and that the worst is likely to be behind us. "There's no doubt that things feel better today, by a lot, than they did in March," Mr. Paulson said. He pointed to the Federal Reserve's decision to help prevent the collapse of Bear Stearns Cos. (NYSE:BSC) and to provide liquidity to other investment banks as "an inflection point" in the crisis (WSJ).

Deutsche Bank CEO Josef Ackermann said, "I think that we are getting closer to the end of the financial crisis, it is not fully over yet, but the signs from the United States are encouraging." Ackermann said that the pragmatic approach in the United States to resolve the crisis should start to pay off soon (Reuters).

Goldman Sachs CEO Lloyd Blankfein said the credit crisis that's forced almost $250 billion in losses and writedowns may be approaching an end. "We're closer to the end than the beginning.'' So when is the ideal time to invest?

According to hedge fund manager Doug Kass, who was one of the few managers to accurately predict the credit crisis, the time is now. "After shunning bank stocks (and being short) for a number of years, I am making a large (and growing) commitment on the long side.

Sentiment toward financials remains at an historic nadir -- the sector represents only 15% of the S&P 500, down from its peak of 23% in 2007 -- as the stock prices have continued their almost never-ending descent.

And in a market in which so many investors/traders seem to worship at the altar of price momentum, that decline has no doubt been accelerated by those momentum-based market participants against a backdrop of almost total unanimity of opinion that the financials are untouchable from the long side...I can make the case that we are now at an unprecedented point of time to get long financials" (thestreet.com)

Oil

"Speculators are largely responsible for driving crude prices to their peaks in recent weeks and the record oil price now looks like a bubble" George Soros recently warned, "the price has this parabolic shape which is characteristic of bubbles." Traditionally, there is a run-up of crude oil future purchases just prior to Memorial Day as traders anticipate a strong start to the summer driving season. But since forecasts by motorist group AAA and Delloite and Touche both expected decreased travel this past holiday weekend, analysts said lower gasoline demand in the United States may finally be catching up to record oil prices.

The U.S. Department of Transportation said Monday that Americans drove 11 billion miles less in March 2008 than a year earlier, marking the first time that estimated March travel on public roads fell since 1979. That 4.3% decline is the sharpest year-on-year drop for any month in the history of the agency's reporting, which dates back to 1942 (CNN Money). A decline in oil prices will be a significant boost to the broad market as fears of a consumer slowdown will dissipate.

US Dollar

GDP rose at an adjusted 0.9% annual rate January through March, the Commerce Department said in the second estimate of first-quarter GDP. That is above the preliminary estimate of 0.6% and has provided the dollar with some much needed confidence. Federal Reserve Bank of Dallas President Richard Fisher, who envisioned a scenario in which the Fed might hike rates even amid a weak economy, said that if inflation and inflation expectations keep getting worse, that he would "expect a change of course in monetary policy to occur sooner rather than later, even in the face of an anemic economic scenario."

What does a strengthening dollar mean for the stock market? It provides us with a multiple booster provided by international investment. We have grown accustomed to low domestic stock price valuations brought on by the weak dollar. Even as our economy experienced its latest boom, p/e ratios remained tame. The ten-year return on the S&P 500 (NYSEARCA:SPY) (NYSEARCA:IVV) sits at a meager 3.5% compared with 6.84% on the European 350 Index (NYSEARCA:IEV) and 12.27% on the MSCI Emerging Markets Index (NYSEARCA:EEM). The second half of this year will bring in international investors who have been elsewhere for years.

A bottom in financials and the US Dollar, combined with a top in oil, provides a nice foundation for the 2nd half of 2008. If recent developments are showing us anything, it's that this story has legs. We are about to enter June and it's time to re position your portfolio for a run through Thanksgiving.

Disclosure: Long IVV